R&D tax refunds and the PPSA: the current state of play

Recent proceedings in NSW Court of Appeal have, in an insolvency context, grappled with the question of whether research and development tax refunds are an account, and therefore a circulating asset for the purposes of s 340(1) of the Personal Property and Securities Act 2009 (Cth) (PPSA). As reflected by the reasons delivered in Resilient Investment Group Pty Ltd v Barnet and Hodgkinson as liquidators of Spitfire Corp (in liq)[1] (Spitfire), the resolution of this issue is a matter upon which eminent judicial minds differ. It is, therefore, not surprising that the issue seems destined for consideration by the High Court, and an application for special leave to appeal the Spitfire decision has been filed. That being the case, this article seeks to do no more than summarise the competing conclusions reached at first instance and on appeal.

Background

Spitfire developed wealth management and share analysis technology as the parent company of the Spitfire Group. It also held research and development (R&D) entity status. Spitfire went into administration on 17 August 2020 and in early 2021, liquidation. Its liquidators filed tax returns for the 2019 and 2020 financial years and received R&D offsets for each of those years totalling about $2 million.

The effect of ss 556, 560 and 561 of the Corporations Act 2001 (Cth) is that in Spitfire’s winding up, certain categories of employees were entitled to receive their entitlements in preference to the interests of secured creditors holding a “circulating security interest”, being an interest in a “circulating asset” defined in s 340 of the PPSA. As the Commonwealth had (under the Fair Entitlements Guarantee scheme) paid those entitlements, the Commonwealth was entitled to stand in those employees’ shoes and obtain the benefit of their priority position.

Accordingly, if the R&D refunds were circulating security interests, then the Commonwealth was entitled to the proceeds in priority to the secured creditor (Resilient). The liquidators applied to the Supreme Court for directions as to the correct treatment of the $2 million refund. For the reasons explored below, Black J at first instance determined that the Commonwealth was so entitled, a decision overturned on appeal.

Are R&D refunds circulating assets?

Whether the R&D refunds are “circulating assets” depends on the construction of s 340 of the PPSA. Subsection 340(1) provides that personal property is a circulating asset if (subject to certain irrelevant exceptions) the personal property is covered by s 340(5).

Subsection 340(5)(a) covers:

(a) an account that arises from granting a right, or providing services, in the ordinary course of a business of granting rights or providing services of that kind (whether or not the account debtor is the person to whom the right is granted or the services are provided); …

It was the nature of accounts covered by this paragraph which were the focus of the reasons at first instance and on appeal. In respect of R&D refunds, this required analysis of two matters: first, whether they were an “account” as defined in the PPSA, and secondly, whether the refunds arose from “providing services, in the ordinary course of a business of … providing services of that kind”.[2]

Chose in action or mere expectancy — a matter of timing

The definition of “account” in s 10 of the PPSA makes clear that the existence of account is predicated on the presence of a “monetary obligation”. Having regard to the insolvency context, this invited consideration of whether R&D refunds could be said to amount to a monetary obligation as at the date of the liquidators’ appointment.

The Commonwealth argued at first instance and on appeal that Spitfire’s right to receive R&D refunds was a chose in action (that is, a right enforceable by action) that came into existence at the end of the relevant financial year and was not dependent on the Commissioner of Taxation issuing an assessment.

Resilient, on the other hand, argued that the only right that arose in relation to the R&D refunds prior to the Commissioner’s assessment was at most a right to require the Commissioner to perform statutory duties under taxation legislation, enforceable by public law remedies. These rights did not create a debt or proprietary right such that, as at the date of the liquidators’ appointment (when no assessment had issued) Spitfire’s rights were not a chose in action but a “mere expectancy”.

The matters upon which Black J relied at first instance to support his Honour’s conclusion that the R&D refunds were property (and more than a mere expectancy) were that:

• Spitfire’s right to require those refunds arose under a statutory regime (namely the Income Tax Assessment Act 1997 (Cth) (ITAA 1997)).
• That ITAA 1997 regime “obliged” Spitfire to bring the R&D offsets to account in calculating its assessable income.
• The right to obtain R&D refunds was not subject to contingencies (where the R&D was done prior to the liquidators’ appointment).
• The fact that returns need to be lodged to obtain the refunds did not mean the R&D refunds were not property.
• It did not matter that the right to the R&D refunds was not enforceable against the Commissioner of Taxation personally (rather they were enforceable against the Commonwealth as a debt).

On appeal, Gleeson JA (with whom Brereton JA agreed) determined the question of the existence of a relevant monetary obligation by reference to whether Spitfire had a chose of action against the Commissioner. His Honour rejected the notion that the ability to calculate the value of the R&D refunds at the end of a financial year was determinative of whether a chose in action lay. Following an analysis of the relevant provisions of the ITAA 97, White JA concluded that “the language of ‘you can get’ a refund in ITAA 1997, s 63–10(1) does not speak of obligation or duty imposed on the Commissioner”.[3]

His Honour indicated that the earliest that a chose in action could arise in respect of the payment of an R&D refund was following the lodgement of the relevant return or otherwise upon the issue of an assessment.

White JA took a different approach. His Honour’s views were briefly stated as follows:

I incline to the view that prior to the date of its administration Spitfire had a contingent asset which should be characterised as property, and the Commonwealth was under a monetary obligation, albeit a contingent obligation, to pay a tax refund; the contingency being that Spitfire lodge its tax returns claiming the tax refunds. …[4]

There is, with respect, much force in his Honour’s textual approach which concentrates on the meaning of “monetary obligation” rather than the existence of a chose in action. Ultimately, however, White JA found that that monetary obligation:

… did not arise from [the provision of services] in the ordinary course of a business of providing services of that kind within the meaning of s 340(5) of the PPSA.[5]

This limb is discussed below.

Did the monetary obligation arise from providing services?

As referred to above, the relevant PPSA “account” must arise from (relevantly) providing services, in the ordinary course of a business of providing services of that kind.

At first instance, Black J construed this requirement broadly, and was satisfied that the R&D refunds arose from:

… the provision of research and development services that were conducted by the subsidiaries that undertook research within the Spitfire Group for the benefit of all companies within the Spitfire Group, in the business of providing services of that kind for the benefit of the companies in the Spitfire Group that traded with customers, and the ultimate benefit of external customers of the Spitfire Group who used its products and services. …[6]

The Court of Appeal took a narrower approach. Gleeson JA (Brereton and White JJA agreeing) found that it was not enough that the R&D activities were undertaken for the benefit of the group’s companies and customers. Their Honours found that:

The entitlement to a tax offset in respect of R&D expenditure arises from the Spitfire group incurring deductible expenses or becoming entitled to claim a deduction in respect of depreciating assets, rather than providing financial platform services to Spitfire’s customers. The entitlement to receive the R&D Refunds does not arise in the ordinary course of providing services of that kind (financial platform services). Even if it be accepted that the R&D activities were for the ultimate benefit of Spitfires’ customers who used its financial platform services, the entitlement to receive R&D Refunds does not arise in the ordinary course of a business of providing such services (financial platform services).[7]

Conclusion

As seen from the discussion above, there were different views at first instance and amongst the Justices of Appeal as to the manner in which the question of the existence of a “monetary obligation” ought to be approached. While the more popular approach distilled the test to a question of whether a chose in action or mere expectancy came into existence, there was disagreement as to matters of timing.

It is difficult to accept that a monetary obligation can arise at the end of a financial year merely because an R&D refund is capable of being calculated. There is a more cogent basis for such an obligation arising upon the lodgement of a return even if the obligation to pay the refund is subject to further contingencies (such as the Commissioner undertaking an assessment according to the ITAA 1997). However, discussion of the broader implications of the treatment of R&D refunds vis-à-vis circulating security interests must necessarily await consideration of the matter by the High Court.